Questions About FDI Policies Implications of Ownership, Location, - - PDF document

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Implications of Ownership, Location, and Internalization Advantages for FDI Policies

Amy Jocelyn Glass Texas A&M University

Questions About FDI Policies

When does foreign direct investment (FDI)

• ccur?

What benefits can FDI provide for host

countries?

What government policies increase benefits

from FDI?

When Does FDI Occur?

Logistics of coordinating activities across

multiple locations can be challenging

Ownership, location and internalization

advantages help overcome difficulties

Operating as a multinational can be

worthwhile, especially as information and communication technologies improve

Ways to Serve a Foreign Market

Export: produce in home market and ship to

foreign market

FDI: produce in foreign market using a

subsidiary

License: produce in foreign market using a

foreign firm

Ownership Advantage

First need a reason why foreign market not

served by a foreign firm

Must be something that domestic firm does

better than foreign firms – domestic firm must be special

Examples: technology (unique product

design, better product, lower cost), superior management or organization skills

Location Advantage

Next need a reason why production should

be located in the foreign market

Must be something that makes production

in foreign country better than production in domestic country – host must be special

Examples: lower factor prices (comparative

advantage), import restraints, rule of law

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Internalization Advantage

Finally need a reason why production

should be kept within one firm

Must be something that makes internal

transactions better than arm’s length

Examples: impossible to write complete

contracts for every possible event, difficult to enforce, risk of opportunistic behavior

Internationalization Strategy

Firms often move from exporting to FDI

and then to licensing as build experience in a country or in similar countries

Technology transfer increases as does

exposure to risk of imitation and

• pportunistic behavior

Hardest to protect ownership advantage

under licensing

What Benefits Can FDI Provide for Host Countries?

Benefits from FDI generally stem from the

existence of ownership advantage

Any firm that engages in FDI must be

special, have some dimension of superiority (often technology) that offsets the inherent difficulty of operating as a multinational

Possible that local firms may be able to gain

from similar ownership advantages

Technology Transfer

Improvements in information and

communication technologies could increase amount of technology transfer that occurs without FDI

Firms could use backward engineering even

if item not produced locally

Patents disclose some information about

inventions that could lower cost of imitation

Easing Technology Transfer

Multinationals may adapt production

technologies to local conditions

Local firms may then have easier time

copying adapted technologies

Workers exposed to technologies may leave

to work for local firms

Part of inventions often kept as trade secret

– firms patent around innovations

Creating Better Jobs

Multinational firms pay higher wages, even

controlling for industry, firm size, etc

Could be creaming (hiring best workers) in

part but also use more capital

Better technologies make workers more

productive and their output more valuable

Workers may be trained to use new

technologies, and some training general

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Linkages From FDI

Forward linkages: added supply lowers cost

• f intermediates – higher profits for local

producers and entry (but possibly lower profit for suppliers and exit)

Backward linkages: added demand raises

price of intermediates – higher profits for local suppliers and entry (but possibly lower profit for producers and exit)

Consumer Benefits

FDI may bring consumer benefits similar to

(but beyond) the benefits of opening up to international trade

Arrival of new varieties or better qualities

• f products to a market

Lower prices for consumer goods than if

imported, especially in the case of substantial import restrictions

What Government Policies Increase Benefits From FDI?

Policies to attract better FDI generally must

augment the location advantage, so host country more special

Important to not tamper with ownership

advantage (what makes firm special)

Examples: infrastructure (highways, ports,

airports), education (computers and foreign language), national treatment, transparency

When Thinking About FDI, Remember OLI!

Ownership, location and internalization

advantages important for understanding when FDI occurs

Ownership advantage influences possible

benefits of FDI

Location advantage determines how best to

attract FDI